Chang and Lean

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African Journal of Business Management Vol. 5(32), pp. 12624-12631,14 December, 2011Available online at http://www.academicjournals.org/AJBMDOI: 10.5897/AJBM11.2220ISSN 1993-8233 2011 Academic Journals

Full Length Research Paper

Stochastic dominance approach of analysis for stockmarket valuation of financial consolidation in Taiwan

Yuan Chang1* and Hooi Hooi Lean2

1Department of Business Education, National Changhua University of Education, Taiwan, Republic of China.

2School of Social Sciences, Universiti Sains Malaysia, Malaysia.

Accepted 20 September, 2011

To examine whether stock market values financial consolidation in Taiwan since 2002, this papercompares the stock market performance of financial-holding-company banks (FHC-bank) withindependent banks using Taiwans daily data from 2003 to 2009. While the ultimate goal of a typicalpublic-traded bank is to maximize its stockholders wealth, based on stock returns distribution, weemploy stochastic dominance (SD) approach to examine relative performance between FHC-banksversus independent banks. The advantage of SD approach is that it lightens the problem that can ariseif the asset returns are not normally distributed because it utilizes the whole distribution of returns.Since SD is nonparametric, SD tests do not require any specific assumptions on investors utilityfunction or the returns distribution of asset and thus avoid the joint test problem inherent in thestandard approach. Most of our evidence shows that there is little dominance in stock returns of FHC-banks relative to independent banks. Thus, Taiwans stock market does not value financial

consolidation during our sample period.

Key words: Financial-holding-company banks (FHC-banks), independent banks, stochastic dominance.

INTRODUCTION

Following the trend of financial liberalization around theglobe, Taiwans government lifted the long-standingrestrictions on the establishment of financial institutions in1988. The Banking Act was amended in 1989, whichpermited new entrants into the banking industry. Severalnew and private banks joined banking markets but

consequently resulted in overbanking problem indomestic financial market. Obviously, the consequence ofabundant entrants leaded to cut-throat competition andthen has seriously worsened the overall financialconditions of all banks. According to the Taiwan Ministryof Finance, overall nonperforming loan ratio climbed fromaround 3% at the end of 1995 to a highest record of8.78% in March 2002. The banking sector in Taiwan

*Corresponding author. E-mail: [email protected]. Tel:886-920-671950. Fax: 886-49-2390387.

JEL classification: C14, C21, G21

suffered from increasing non-performing loans anddecreasing profitability duo to deregulation in 1989.

In order to alleviate the overcompetition of banks andelevate the financial system to a new stage of competi-tiveness in global financial markets, Taiwan governmentdecided to conduct banking financial reforms before

millennium. Almost at the same time, in the UnitedStates, the announcement of the Citigroup merger in1998 sped up the process of financial consolidation, andafterwards the Congress passed the Gramm-Leach-BlileyAct (GLBA) in 1999. Through the roof of Financial-holding-company banks (FHC), a financial institution canengage in banks, insurances and securities at the sametime.

The GLBA in U.S. encourages the financial regulatorsin Taiwan government to speed up the financial consoli-dation reforms. In 2000, Taiwan passed the amendedBanking Law and the Financial Institutions ConsolidationLaw, while in 2001, FHC Act was stipulated to encouragethe consolidation within and cross banking sectors. TheFHC holds atleast 25% shares of banks, insurance and


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securities, hoping to create economies of scale andscope to save cost and improve performance of conso-lidated banks.Since the passed of FHC Act, 14 FHCs are

established successively. In the early stage, 13 banksjoined the FHCs. Later on, an additional four banks joinedin. Thus, there are now a total of 17 FHC-banks and 17independent banks in Taiwan. Although the backdrop andthus the presupposition of Taiwans financial reform arebased on the conventional wisdom in banking literaturewhich argues that banks could reduce their risks andimprove performance through diversification, empiricaltest about whether this policy improve stockhoderswealth is also needed, especially, recent alarmed finan-cial tsunami shows that banks with higher and aggressivediversity could increase risks and result in worseperformance. Therefore, does a bank, subordinated to

financial holding company (FHC-bank thereafter)outperform a bank to be stand-alone (independent bankthereafter)? This is a greatly-concerned issue bygovernment decision makers and academic researchers,especially since the passage of the Financial HoldingCompany Act in 2001 to reconstruct financial hierarchy inTaiwan.

Theoretically, Diamond (1984), Ramakrishnan andThakor (1984), and Boyd and Prescott (1986) suggestedthat banks could achieve credibility in their role asscreeners or monitors of borrowers through diversification,thus supported that FHC-bank is superior because banksthat engage in deposit-loan activity can facilitate theefficient provision of other financial services, such asinsurance or underwriting of securities (Diamond, 1991;Rajan, 1992; Saunders and Walter, 1994; Stein, 2002).Similarly, securities and insurance underwriting,brokerage and mutual fund services and other activitiescan produce additional information that improve loanmaking decisions. Thus, banks in financial conglomerate,because of 3C (cross-selling, cost down and capitaldown), could enjoy economics of scale and scope thatboost performance and market valuations. Also, underframework of financial holding company, the service ofone-stop shopping from banking, insurance, andsecurities is possible.

On the contrary, an alternative view suggests that

independent banks may have specialization advantageand lower systematic risks.

1For example, some indepen-

dent-banks are specialized in credit card or custodianbusiness and then join the FHC has no particularadvantages for them. Also, independent bank could havelower systematic risk because a FHC-bank with diver-sified activities will reinforce agency problem betweeninsiders and outsiders. For examples, Jensen (1986)proposed that insiders have incentives to expand therange of financial activities if this diversification enhancespersonal advantages or extract private benefits from thefinancial institution. Although their focus is not financial

1 Shen (2002) described the advantages and disadvantages of banks beingsubordinated to FHC and independent.

Chang and Leann 12625

institution, Jensen (1986), Berger and Ofek (1995),Servaes (1996), and Denis et al. (1997) argue that thebenefits of diversification are less than the costs.

Therefore, conflicts of interest and agency problems haveadverse implications on the performance or marketsvaluation of a bank. A bank should focus and take themaximum advantage of managing expertise and thusreduce agency problems.

The number of empirical studies comparing theperformance of FHC-bank and independent bank is rare,probably because the banks with similar assets size inand not in FHC are rare. Shen (2002) examined CAMELindicators of 50 FHC-banks and 44 independent ones inU.S between 1997 and 1998, and found that on average,the former outperform the latter. Hsu and Chang (2005)studied the influence of passage of FHC Act on bank

operational efficiency in Taiwan. They found that FHC-banks outperform independent-banks before and afterpassage of FHC Act, and this gap widens after passageof that Act. Boyd and Graham (1988) found banks whichare merged with insurance companies have lower risk ofbankruptcy. Rose (1989) suggested that banks engagedin non-bank product lines will reduce cash flow risk.Templeton and Severiens (1992) found that banks withdiversification among other financial services will reducetheir unsystematic risk. Berger et al. (1999) showed thathigher financial service consolidation drives greaterdiversification of risk.

On the contrary, Berger et al. (1987) and Berger andHumphrey (1991) provided little evidence of largeeconomies of scope by estimating the trans-log costfunction of banks, similar with the results of Ferrier et al.(1993) and Pulley and Humphrey (1993). DeYoung andRoland (2001) found that U.S banks with lower traditionallending activities and higher fee-based activities havehigher revenue volatility and thus risks. Stiroh (2004)showed that noninterest diversification is negativelyrelated to banks performance. Other studies examine theeffects of conflicts of interest when a bank both makesloans and sells its securities. For examples, Kroszner andRajan (1994), Puri (1996), Gande et al. (1997, 1999), andSchenone (2004) found the results of banks which makeloans to a firm and underwrite its securities will sell

securities to the public at inflated prices to subsidize theirlending operations. Cerasi and Dal-tung (2000), andAcharya et al. (2006) suggested that there are diseconomiesof scope that arise through weakened monitoringincentives and a poorer quality loan portfolio when a riskybank expands into additional industries and sectors.Laeven and Levine (2007) found that financialconglomerates engaging in multiple lending activitieshave lower market value than they would if they weresplit into separate financial institutions.

While numerous studies are concentrated on U.S. andEuropean banking markets, leaving the Asian emergingeconomies such as Taiwan (with relative importance in

stock market Asia) passed over; this is the first motivationfor our paper. Secondly, banks performance comparisons


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12626 Afr. J. Bus. Manage.

Table 1. FHC-banks vs. independent-banks.

FHC-banks Independent banks

First Commercial Bank Hsinchu International BankHua Nan Commercial Bank Taichung Commercial Bank

Cathay United Bank Tainan Business Bank

Bank SinoPac Taitung Business Bank

E.SUN Commercial Bank EnTie Commercial Bank

Taishin International Bank Farmer Bank

Mega International Commercial Bank Taiwan Corporative Bank

China Development Industrial Bank Chang Hwa Bank

Chinatrust Commercial Bank Bank of Overseas Chinese

Taipei Fubon Bank Cosmos Bank

Chiao Tung Bank Pan Asia Commercial Bank

Fuhwa Commercial Bank Bank of Kaohsiung

Jih Sun International Commercial Bank Union Bank of TaiwanInternational Bank of Taipei Chinese Bank

Grand Commercial Banks Far Eastern International Bank

Fubon Commercial Bank Taiwan Business Bank

Cathay Bank Ta Chong Bank

Source: website of Financial Supervisory Commission, Executive Yuan(http://www.fscey.gov.tw).

of various existing papers are not based on stockholderswealth. For a typical public-traded company, the goal is tomaximize its stockholders wealth based on stock returns

distribution, thus our paper are based in stock marketsperformance comparisons to analyze relativeperformance between FHC-banks versus independentbanks. Thirdly, near a decade after FHC Act, we need anex post evaluations of the policy impacts of the change inlegislation and regulatory environment of Taiwansbanking industry, which might provide an exogenousmotive for banks to diversify and thus impacts on theirstockholders wealth.

Based on Hadar and Russell (1969), Hanoch and Levy(1969), and Rothschild and Stiglitz (1970), Whitmore(1970) introduced stochastic dominance (SD) theory toeconomics research. The basic principle underlying SDgrounds on the maximization of expected utility. Anadvantage of this approach is that it lightens the problemsthat can arise if the asset returns are not normallydistributed because it utilizes the whole distribution ofreturns. Moreover, since SD is nonparametric, SD testsdo not require any specific assumptions on investorsutility function or the returns distribution of asset and thusavoid the joint test problem inherent in the standardapproach. SD rankings also have direct interpretations interms of expected utility and thus provide an appealingbasis to relate investors revealed preferences to their riskattitudes (Fong, 2009).

This paper investigates the stock performance with theSD approach between FHC-banks and independent

banks in Taiwan Stock Exchange (TWSE).

BRIEF ACCOUNT OF FHC IN TAIWAN

Wheelock (1993) suggested that the overdevelpoment of

banking is more responsibile than any other factos for thebanking disaters. Starting from the middle of 1980's,Taiwan started to deregulate its financial markets, suchas liberalization for bank branch expansion in 1984,removal of interest rate control in 1985 and policy reformfor introduction of newly-establish banks. However andunfortunately, as Wheelock (1993) said, overbankingproblem soon emerged, overall health of the bankingsystem quickly decreased.

As Taiwans first financial reform proposed byPresident Chen, the government referred to U.S FinancialServices Modernization Act (Gramm-Leach-Bliley Act) forremoval of separation prohibition of banking and invest-ment (Glass-Steagall Act) to strengthen financial industry,Finance Holding Company Act passed in 2001 and 14domestic financial holding companies were establishedsuccessively in Taiwan. Table 1 summarizes the names,dates of approbation for establishment, date of open forbusiness and banks subordinated to each of the 14financial holding companies.

In order to get complete financial information aboutbanks, we collect data of banks which are Taiwan StockExchange listing companies. In our sample period from2003 to 2009, 13 banks are subordinated to financialholding companies, which are (1) Bank SinoPac, (2) HuaNan Commercial Bank, (3) Cathay United Bank, (4) FirstCommercial Bank, (5) E.SUN Commercial Bank, (6)

Taishin International Bank, (7) International Commercial


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Bank of China, (8) China Development Industrial Bank,(9) Chinatrust Commercial Bank, (10) Taipei Fubon Bank,(11) Chiao Tung Bank, (12) Fuhwa Commercial Bank,

(13) Jih Sun International Commercial Bank.There are 4other banks which are defined as FHC-

banks but go through consolidation during our sampleperiod : (1) International Bank of Taipei, which areconsolidated into Sinopac Holdings in 2005Q2; (2) GrandCommercial Bank, merged into Chinatrust CommercialBank in 2003Q4; (3) Fubon Commercial Bank, mergedwith Taipei Bank merged into Taipei Fubon Bank and theformer is eliminated and (4) Cathay United Bank, whichare merged with United World Chinese Commercial Bankin 2003Q4, the former is eliminated and former is thesurviving bank but the merged bank is re-named asCathay United Bank. For these 4 banks subordinated to

financial holding companies, we have their data from2002Q1 (first quarter of 2002) to one quarter beforeeffectiveness of consolidation.

During our sample periods, independent banks are: (1)Hsinchu International Bank, (2) Taichung CommercialBank, (3) Tainan Business Bank (renamed as KingsTown Bank in 2006Q1), (4) Taitung Business Bank, (5)EnTie Commercial Bank, (6) Farmer Bank, which mergedinto (7) Taiwan Corporative Bank in 2006Q2, (8) ChangHwa Bank, (9) Bank of Overseas Chinese, (10) CosmosBank, (11) Pan Asia Commercial Bank (renamed asBowa Bank 2005Q2), (12) Bank of Kaohsiung, (13) UnionBank of Taiwan, (14) Chinese Bank, (15) Far EasternInternational Bank, (16) Taiwan Business Bank and (17)Ta Chong Bank.

DATA AND METHODOLOGY

As aforementioned, although there are 17 independent banks and14 FHC listing on Taiwan Stock Exchange (TWSE), however,complete daily data of stock returns is collected from TaiwanEconomic Journal (TEJ) for only 5 independent banks and 13 FHC-banks listed in TWSE. The sample period of study is from January2, 2003 to December 25, 2009, which includes the recent globalfinancial crisis. For the 5 independent banks, we name it as I1, I2,, I5. For the 13 FHC banks, they are named as F1, F2, , F13.

We use a nonparametric approach based on stochastic

dominance (SD) to compare the stock return between FHC banksand independent banks. Hadar and Russell (1969), Hanoch andLevy (1969), Rothschild and Stiglitz (1970) and Whitmore (1970) laythe foundation of SD analysis. The basic principle of SD isgrounded in maximizing expected utility. Thus, SD rankings havedirect interpretations in terms of expected utility. Since SD approachutilizes the whole distribution of returns, the problems of assetreturns not normally distributed can be minimized. Moreover, thereare no specific assumptions on investors utility function whenemploying SD test. This can avoid the joint test problem intrinsic inthe standard statistical testing approach.

If all non-satiated investor prefer the distribution of stock return ofa FHC bank to the independent bank, then risk compensation isunlikely to be an explanation for the profitability of FHC banks.Suppose an investor is choosing between two risky prospects Yand Z, let Fand G be the cumulative distribution functions (CDF)

and, f and g are the corresponding probability density functions(PDF) respectively. Defined as:


0H h= and ( ) ( )1x

j ja

H x H t dt

= for h = f, g ,

,H F G= and

1,2,3j= . (1)

The most commonly-used SD rules that correspond with threebroadly defined utility functions are first-, second- and third-orderSD denoted by FSD, SSD and TSD respectively.

Under FSD criterion, all investors are non-satiation which meansinvestor prefers more to less, regardless his risk preference. If theCDF of Ys return is below Zs for all values, we say that prospect Ydominates prospect Zat first-order. Mathematically, it is denoted as

1Y Zf if and only if ( ) ( )1 1F x G x . SSD assumes that thenon-satiation investors are risk averse. Prospect Y dominates

prospect Z at second-order, denoted 2Y Zf if and only if

( ) ( )2 2F x G x . In addition, TSD assumes that the risk averse

investor has decreasing absolute risk aversion (DARA), or in otherword he prefers positive skewness. Prospect Ydominates prospect

Z at third-order, denoted 3Y Zf if and only if

( ) ( )3 3F x G x for all possible return x.The existence of SD implies that the expected utility of the

investor is always higher when holding the dominant asset thanholding the dominated one and, consequently, the dominated assetwould not be chosen. As noted by Levy (1992, 1998), hierarchicalrelationship exists in SD. FSD implies SSD, which in turn impliesTSD; the reverse is not true.

There are statistical tests for SD which have been welldeveloped, for example, McFadden (1989), Klecan et al. (1991),Kaur et al. (1994), Anderson (1996, 2004), Davidson and Duclos(2000), Barrett and Donald (2003) and Linton et al. (LMW, 2005).We choose to use DD test in this study because Wei and Zhang(2003), Tse and Zhang (2004) and Lean, Wong and Zhang (2008)reported that DD test is powerful and less conservative in size.Furthermore, DD test is flexible if the series being examined isdependent.

For any two prospects, Yand Zwith CDFs Fand Grespectivelyand with a grid of pre-selected points x1, x2 xk, the order-jDD test

statistics, ( )jT x (j= 1, 2 and 3) is formulated as:

( ) ( )( )

( )

j j

j

j

F x G xT x

V x

= (2)

, ( ) ( ) ( ) 2 ( ),

j j j

j Y Z Y ZV x V x V x V x= +

1

1

1 ( ) ( ) ,( 1)!

Nj

j i

i

H x x hN j

+

=

=

( )

2( 1) 2

21

11

, 21

1 1 ( ) ( ) ( ) , , ; , ;(( 1)!)

1 1 ( ) ( ) ( ) ( )(( 1)!)

Nj j

H i j

i

Njj j

Y Z i i j j

i

V x x h H x H F G h y zN N j

V x x y x z F x G xN N j

+

=

+ +

=

= = =

=

where jF and jG are defined in (1). Bishop et al. (1992)


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proposed to test the null hypothesis for a pre-designed finitenumbers of values x. Specifically, the following hypotheses aretested:

( ) ( ) ( ) ( )

( ) ( ) ( ) ( )

0

1

2

: ( ) ( ) for all , 1,2,..., ;

: ( ) ( ) for some ;

: for all , for some ;

: for all , for some .

j i j i i

A j i j i i

A j i j i i j i j i i

A j i j i i j i j i i

H F x G x x i k

H F x G x x

H F x G x x F x G x x

H F x G x x F x G x x

= =

We note that in these hypotheses, AH is set to be exclusive of

both 1AH and 2AH , which means that if either 1AH or 2AH is

accepted, we will not say AH is accepted. Under the null

hypothesis, DD showed that ( )jT x is asymptotically distributedas the Studentized Maximum Modulus (SMM) distribution(Richmond, 1982) to account for joint test size. To implement theDD test, the test statistic at each grid point is computed and the nullhypothesis is rejected if the test statistic is significant at any gridpoint. The SMM distribution with kand infinite degrees of freedom,

denoted byk

M, is used to control for the probability of rejecting

the overall null hypotheses. The following decision rules are

adopted based on 1- percentile ofk

M, tabulated by Stoline

and Ury (1979):

, 0

, , 1

, , 2

,

If ( ) for 1,..., , accept ;

if ( ) for all and ( ) for some , accept ;

if ( ) for all and ( ) for some , accept ; and

if ( ) for s

k

j i

k kj i j i A

k k

j i j i A

k

j i

T x M i k H

T x M i T x M i H

T x M i T x M i H

T x M

< =

< >

< >

> ,ome and ( ) for some , accept .k

j i Ai T x M i H >

Accepting either H0 or HA implies non-existence of any SDrelationship, non-existence of any arbitrage opportunity betweenthese two prospects and neither of these two prospects are

preferred to one another. However, if 1AH or 2AH of order one isaccepted, a particular prospect stochastically dominates anotherprospect at first-order. In this situation, arbitrage opportunity canexist and any non-satiated investor will be better off if s/he switchesfrom the dominated prospect to the dominant one. On the other

hand, if 1AH or 2AH is accepted for order two or three, aparticular prospect stochastically dominates the other at second- orthird-order. In this situation, arbitrage opportunity does not exist andswitching from one prospect to another will only increase investorsexpected utilities, but not wealth (Jarrow, 1986; Falk and Levy,1989).

DD test compares the return distributions at a finite number ofgrid points. Richmond (1982) argued that too many grids will violatethe independence assumption required by the SMM distributionwhile Barrett and Donald (2003) noted that too few grids will missinformation of the distributions between any two consecutive grids.Tse and Zhang (2004) suggested that an appropriate choice of kfora reasonably large sample ranges from 6 to 15. To make moredetailed comparisons without violating the independenceassumption, we follow Fong et al. (2005), Lean et al. (2007) and

Wong et al. (2008) to make 10 major partitions with 10 minorpartitions within any two consecutive major partitions in each

comparison and to make the statistical inference based on theSMM distribution for k =10 and infinite degrees of freedom2. Thisallows the examination of the consistency of both magnitudes andsigns of the DD statistics between any two consecutive majorpartitions without violating the independent assumption.

EMPIRICAL RESULTS

Table 2 reports the descriptive statistics of the stockreturns for independent and FHC-banks during sampleperiod. Daily mean return of FHC-banks is higher thanthe independent banks in average for about 70% (0.0491and 0.0283%, respectively). Because all the banks havepositive daily mean return, neither FHC- nor independentbanks experienced any negative average return eventhough the global financial crisis happened during the

sample period.Although FHC-banks have higher return than

independent banks, their average standard deviation islower as well (2.2794 and 2.3017%, respectively). Basedon the mean-variance criterion, FHC-banks are superiorto the independent banks with higher return and lowerrisk. In addition, higher Sharpe ratio of FHC-banks thanindependent banks (0.0213 versus 0.0117) also showsthat investment in FHC-banks is better off. However, theindependent banks have larger skewness and kurtosis inaverage than the FHC banks. Hence, we conclude thatFHC banks are better off than the independent banksfrom the descriptive statistics and mean-variance cri-

terion. This is consistent with the literature such as Boydand Graham (1988), Rose (1989) and Templeton andSeveriens (1992) which show evidence that diversifiedbanks are with lower risks.

Then, we do the pair-wise SD comparisons byemploying the DD test for all banks in these two groups.To do this, we replace the first variable (F) with FHC-bank and the second variable (G) with independent bankin Equation 2. If the FHC-bank stochastically dominatesthe independent bank at order-j, there will not be anysignificantly positive Tj but there will be some significantlynegative Tj.

The DD test results are summarized in Table 3. Ingeneral, the number of cases that FHC bank dominatesindependent bank (15 cases) are approximately equal tothe number of cases that FHC bank is dominated byindependent bank (14 cases). A non-satiation risk-averseinvestor is indifferent between FHC-banks and indepen-dent banks to maximize his expected utility, on average,based on their stock return during the sample period. Inother word, being a FHC-bank does not bring anyobvious advantages on stock market performance in termof motivate a risk-averse investors preference to buy itsstock.

We can observe some domination for individual bank.

2 Refer to Lean et al. (2008) for the reasoning. Critical value is 3.254 for 5%level of significance tabulated in Stoline and Ury (1979).


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Table 2. Descriptive statistics for independent and FHC banks in Taiwan.

Banks Mean Std. dev. Skewness Kurtosis Sharpe

IndependentI1 0.0302 2.2241 0.1834 1.4315 0.0136

I2 0.0607 2.5702 0.2292 1.3615 0.0236

I3 0.0057 2.2884 0.1640 1.6337 0.0025

I4 0.0069 1.9675 0.1991 3.0330 0.0035

I5 0.0380 2.4583 0.2514 1.2711 0.0154

Average 0.0283 2.3017 0.2054 1.7462 0.0117

FHC-

F1 0.0360 2.0826 0.0854 2.2214 0.0173

F2 0.0592 2.2025 0.0682 1.7427 0.0269

F3 0.0683 2.2826 0.0752 1.5959 0.0299

F4 0.0147 2.1554 0.1191 1.7272 0.0068F5 0.0319 2.0943 0.1076 2.0815 0.0152

F6 0.0974 2.6982 0.1173 0.7090 0.0361

F7 0.0518 2.1053 0.1492 2.1180 0.0246

F8 0.0297 2.4410 0.2068 1.4288 0.0122

F9 0.0771 2.7792 0.1330 0.6165 0.0277

F10 0.0624 1.9701 0.2486 2.9471 0.0317

F11 0.0296 2.2865 0.1151 1.4941 0.0129

F12 0.0466 2.3546 0.0640 1.6265 0.0198

F13 0.0337 2.1804 0.1979 2.0224 0.0154

Average 0.0491 2.2794 0.1298 1.7178 0.0213

The independent banks, I1~I5 are Chang Hwa Bank, Tainan Business Bank (now known as King'sTown Bank), Bank of Kaohsiung, Union Bank of Taiwa and EnTie Commercial Bank. Among FHC-

banks, some of them are from Table 1, and others are newly established.

Table 3. SD tests results between independent and FHC banks in Taiwan.

Bank I1 I2 I3 I4 I5 #D #T

F1 N D D* N D 3 0

F2 N D N N N 1 0

F3 N N N T N 0 1

F4 N D N N N 1 0

F5 N D N N D 2 0

F6 T N T T N 0 3

F7 N D D N D 3 0

F8 T N N T N 0 2

F9 T T T T T 0 5

F10 D D D N D 4 0

F11 N N N T N 0 1

F12 T* N N T N 0 2

F13 N D N N N 1 0

Total 15 14

D means dominates at second-order and third-order; T means is dominated at second-order andthird-order; N means no stochastic dominance and * refers to first-order dominance. For example,F1 D I2 means bank F1 dominates bank I2 at second-order and third-order; F1 N I1 means thereis no stochastic dominance between F1 and I1; F6 T I1 means bank F6 is dominated by bank I1 atsecond-order and third-order. #D means number of independent bank that is dominated by theparticular FHC bank; #T means number of independent bank that dominates the particular FHC

bank. For example, row F1 shows bank F1 dominates 3 independent bank banks and it is notdominated by any independent bank.


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Table 4. SD tests results between independent and FHC-Banks using after-matching samples.

Bank I1 I2 I3 I4 I5 #D #TF5 N D N N D 2 0

F8 T N N T N 0 2

F9 T T T T T 0 5

F10 D D D N D 4 0

F11 N N N T N 0 1

Total 6 8

Similar with Table 3.

F10 performs the best as it dominates four independentbanks while F9 performs the worst because it is

dominated by all the five independent banks. F1 and F7also doing quite well in dominating three independentbanks while F6 is dominated by three independent banks.

There are two cases of FSD: F1 is FSD I3 while I1 isFSD F12. Many studies such as Jarrow (1986) and Falkand Levy (1989) claim that if FSD exists, under certainconditions arbitrage opportunities also exist, andinvestors will increase their wealth and expected utilities ifthey shift from holding the dominated asset to thedominant one. However, Wong et al. (2008) claim that ifFSD exists statistically, arbitrage opportunities may notexist, but investors can increase their expected wealth aswell as their expected utility if they shift from holding thedominated asset to the dominant one. In general, the

FSD should not last for a long period of time becausemarket forces induce adjustments to a condition of noFSD if the market is rational and efficient. In a situationwhere the FSD holds for a long time and all investorsincrease their expected wealth by switching their assetchoice, we claim that the market is neither efficient norrational. Another possibility for the existence of FSD to beheld for a long period is that investors do not realize thatsuch dominance exists.

While our comparisons are based on FHC-banks andindependent banks, one might wonder if we couldattribute the stock market performance difference to theeffects of banks joining FHC on performance. Because of

banks characteristic variables such as scale, debt ratioand the ratio of revenue from non-traditional activities tototal revenue, we try to match similar-in-characteristicsFHC-banks with independent banks. Why we do this isthat because the classification of FHC- versusindependent banks is not a random process and may beendogenously determined. For example, banks withbetter accounting performance in the past tend to joinFHC, or banks with large scale tend to join FHC. If thispossibility exists, stock market performance differencesbetween two group may not be attribute to effect ofjoining FHC.

Rubin (1973a, b) developed matching theory, and then

Rosenbaum and Rubin (1983, 1985a, b) proposed pro-pensity score matching (PSM), both are intuitive methods

to match samples with similar charactersitics. The basicconcept of Rubin (1973a, b) is that non-participants ofexperiment (firms without doing CSR) that have similar

characteristics with participants (CSR firms) are calledthe controlled samples. Thus, the changes owing to theexperiment between treatment sample and controlsample is referred to as experimental or treatment effect(purely joining-FHC effects). The PSM firstly estimate theprobability of including in the experiment (propensityscore) by all samples using characteristic variables as theexplanatory variables. Then for each firm in the treatmentsample, firms in the control samples are selected asmatched samples according to the closeness of theestimated probability (Shen and Chang, 2009).

We employ Rosenbaum and Rubins (1983, 1985a, b)PSM to collect samples of FHC-banks which share simi-

lar characterisic varaibles with independent banks. Forsimplicity, characteristic variables are ASSET(natural logcurrent-period total assets), DEBTL (last-period debtratio) and PROFITL (last-period after-tax profits levels).Thus, after matching, we have 5 FHC-banks and 5independent banks.

Based on after-matching samples, the DD test resultsare summarized in Table 4. In general, the number ofcases that FHC bank dominates independent bank (6cases) are approximately equal to the number of casesthat FHC bank is dominated by independent bank (8cases). A non-satiation risk-averse investor is indifferentbetween FHC-banks and independent banks to maximizehis expected utility, on average, based on their stockreturn during the sample period. In other word, being aFHC-bank does not bring any obvious advantages onstock market performance in term of motivate a risk-averse investors preference to buy its stock.

We can observe some domination for individual bank.F10 performs the best as it dominates four independentbanks while F9 performs the worst because it isdominated by all the five independent banks. F5 is alsodoing quite well in dominating two independent bankswhile F8 is dominated by two independent banks.

Conclusion

Taiwans financial consolidation reform in 2001 are basedon the conventional wisdom which advocates that bankdiversification reduce risks and enhence performance. Inaddtion, recent financial tsunami shows that financaildiversification lead to higher risks and lower performance,now, nearly a decade after FHC Act was passed, weneed an evaluations of the policy impacts of the changein legislation and regulatory environment of Taiwansbanking industry, which provide an further motive forbanks to diversify and policy implication for stockholderswealth of banks.

Empirically evidence shows that there is dominance in

stock returns of FHC-banks relative to independent banks.Thus, Taiwan stock market does not price financial


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consolidation during our sample period, and governmentpolicy persuades banks to stretch their optimal scope andaggressively diversify themselves in order to improve in

stockholder wealth of banks. Future study needs tomatch samples for similar size or other characteristicvariables (Rosenbaum and Rubin, 1985a, b) to control forscale effect on performance and lengthening the data toexamine the synergic effects of bank consolidation onperformance is also needed.

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